European Government Bonds: Too Early For The ECB To Announce A Change In Guidance

Spain’s government bond rating has been upgraded by Fitch to A- from Baa+, Greece has also seen the rating lifted by Standard &Poor’s, and the US once again experiences a shutdown of non-essential government operations. The biggest topic for the bond market, however, will be the press conference of the European Central Bank (ECB) scheduled for Thursday.

Investors will recall that the minutes of the December meeting caused a sharp correction of the European government bonds. According to the December minutes (also called ‘accounts’), several members of the ECB Board questioned the need for monetary support and saw the necessity to prepare the market for a tightening move. Ever since then, the market has debated the likelihood of ECB President Draghi changing his forward guidance. Up to now, the ECB has kept stating that rates will remain unchanged longer than the ECB purchases government bonds (current programme supposed to end in September). As expected by Julius Baer’s anlaysts

The ECB to wait until 2019 to raise rates. That said, we still do not see value in any segment the ECB is distorting with its outsized purchases, i.e. government debt and non-financial corporate bonds. We still see subordinated debt of solid European banks as one of the few segments that still generates a decent yield.

On the other hand, BoAML’s experts think that far from the “peace and quiet”, the ECB probably thought it had bought itself last October. This clearly suggests the press conference this week will not be an easy one for Draghi.

This reflects what we highlighted before: changing one part of forward guidance opens the door to the market questioning every single bit of it. Still, we would expect Draghi to emphasize that any changes to forward guidance will only be gradual and that the sequencing (rate hikes only after net QE purchases are over) is something that will not be altered.

Those expecting rate hikes at the end of this year may end up being disappointed. Finally, we do not expect any major change to forward guidance this week apart from the removal of the asymmetry in QE, which we do not think would be consequential.